Ansell: The glove fits

We tend to make judgements too quickly. That’s one of many fascinating findings in Daniel Kahneman’s book Thinking, Fast and Slow. In fact, we’re predisposed to seek out information that confirms beliefs we already hold. It’s a dangerous tendency, especially when it comes to investing.

When Ansell piqued my colleague’s interest, I struggled with the idea. How can a glove and condom maker be profitable? Isn’t this a commoditised industry where sub-par returns are the norm? Well, I was wrong and my colleagues and Kahneman were right.

Everyone knows, perhaps intimately, Ansell’s consumer gloves and condoms businesses. These are but a fraction of this century-old company’s operations. Ansell operates four inter-related but distinctly different businesses. Let’s have a look at each.

The industrial division produces hand and upper arm protective gear for a variety of industrial applications, including tradespeople and chemical plant workers (see Table 1). It’s Ansell’s most profitable business, generating 52% of earnings before interest and tax (EBIT) (see Chart 1). A growing market for personal protective equipment, driven by tighter occupational health and safety (OH&S) regulation in developed economies, has offered a nice tailwind for the company.

Table 1: Product example

Brand	Use	Example
HyFlex	Construction, trades, factories
Activarmr	Military, emergency services, construction
Trellchem	Chemical protective suits
AlphaTec	Labs, pharma, cleaning, construction

The medical gloves business produces disposable gloves for surgical and general medical use. Ansell has pioneered gloves that are easier to don, have reduced allergic effects and even include moisturiser. Still, it’s a business that faces tough competition. Chart 1 shows its consistently lower EBIT margins.

The 'Sexual Wellness’ division produces condoms and accessories—no giggling please, this is serious. Despite the rise of alternate birth control methods, condoms are low cost and the only effective solution for preventing sexually transmitted infections. This division benefits from growing underlying demand and low price sensitivity.

Ansell’s fourth division houses its consumer gloves business, poorer performing product lines and new ventures, including military gloves and chemical suits (see Table 1). This is a business delivering improving returns with the potential for further margin expansion.

Individually, these businesses aren’t wildly attractive. Together, they’re far more compelling.

Having all four operations under one roof leads to manufacturing efficiencies, allowing Ansell to produce higher quality products at a price lower than its competitors. That’s a significant advantage.

Product innovation

Product innovation is also more efficient. For example, the manufacturing process developed to produce extremely thin synthetic-latex condoms was easily transferable to new premium surgical gloves.

Then there are the sales and distribution benefits. With a large sales force cross-selling each division’s products, Ansell can reach more customers. Would-be competitors struggle to match the price, service and relationships Ansell can deliver.

Together, these divisions also offer an in-built hedge. The more volatile, higher return, industrial business is offset by the steadier medical business, and demand for condoms isn’t affected by economic cycles at all. As a portfolio of businesses, they sit well together. It’s unlikely that Ansell would face a situation where all four were performing poorly at the same time.

Unless of course the weather in Malaysia was really bad. Ansell’s operations are beholden to latex pricing (and, to a lesser extent, cotton and butadiene), which can swing wildly depending on Malaysian weather conditions. Management is addressing this reliance on one of its principal inputs by launching new products that use less or no latex. In 2012, for example, it reduced latex consumption by 18%, despite increasing sales.

The industrial division is exposed in another way. In 2008/09, US automotive companies laid off workers, which affected demand for Ansell products. A deep and enduring recession in Europe would have a similar effect. Again, there’s nothing management can really do to avoid that.

What is within management’s control is its desire to expand. When we last looked at Ansell in detail (see Ansell offers slim protection from 14 Apr 10 (Hold – $11.88), chief executive Magnus Nicolin was making loud proclamations about rapid expansion, raising the spectre of ill-conceived and over-priced acquisitions.

European acquisition

Thus far, those fears have proven unfounded. Indeed, the latest purchase of European industrial glove maker Comasec for €102m, on a valuation of around one times sales, appears shrewd. Net debt-to-equity, however, has jumped to around 25% and we wouldn’t like to see it creep much above 30%.

Operationally, 2013 will see an accelerated release of new products that should help lift sales. Ansell’s new IT system is also finally operational, which may boost earnings by between $5m-$10m a year. Additionally, the recent Comasec acquisition may lift earnings by a further $5m.

Then there are the ‘nice if it happens’ effects. If latex prices remained flat (let alone fell), earnings would increase by around $5m. A lower Aussie dollar would also help.

So Ansell isn’t just another average business. Scale, innovation and a vast, entrenched sales network means the company should remain far more profitable than a cursory examination of its financials might imply.

So what’s it worth? Currently, Ansell trades on a PER of 15.7 and offers an unfranked yield of 2.3%. If we assume earnings grow by 5% over the next five years and the company continues to recycle its spare cash into share buy backs, a price of around $15 per share would be reasonable—not so far from the current share price of $15.55.

It’s not hard to imagine total returns reaching 10% a year, in which case at the current share price Ansell would be a reasonable business for a reasonable price. But in this market, more so than any other, buying well is critical. We can’t recommend a stock like this without a decent margin of safety. And at current prices, there isn’t one.

At a price of around $14 we’d look to upgrade to a Long Term Buy but we’re happy to bide our time until then. So, we’re recommencing coverage with a comfortable HOLD, patiently waiting for a time when we can buy in. There’s a good chance we’ll get our opportunity.